Financial Management
Mock Exam
Course Introduction
Financial Management is a foundational course that introduces students to the principles and practices involved in the effective management of an organization's financial resources. The course covers key topics such as financial analysis, planning and forecasting, budgeting, capital structure, investment decision-making, and risk management. Students will learn to evaluate financial statements, understand the time value of money, analyze investment opportunities, and make informed decisions regarding the acquisition and allocation of funds. Emphasis is placed on strategies for maximizing shareholder value while managing financial risks and ethical considerations in financial decision-making. This course equips students with the essential tools and analytical frameworks needed to support sound financial decisions in both corporate and personal finance contexts.
Recommended Textbook Fundamentals of Corporate Finance 4th Edition Jonathan Berk
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Page 2
Chapter 1: Corporate Finance and the Financial Manager
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Q1) What is the term for the applicable price that I will pay, if I have to buy a stock?
Answer: The buyer of a stock pays the ask price when he buys the stock.
Q2) Financial decisions require that you weigh alternatives in strictly monetary terms.
A)True
B)False
Answer: False
Q3) The shares of private corporations are traded on a stock market.
A)True
B)False
Answer: False
Q4) Which of the following is NOT an advantage of a sole proprietorship?
A) single taxation
B) ease of setup
C) unlimited liability
D) no separation of ownership and control
Answer: C
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Chapter 2: Introduction to Financial Statement Analysis
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Q1) A manufacturer of plastic bottles for the medical trade purchases a new compression blow molder for its bottle production plant. How will the cost to the company of this piece of equipment be recorded?
A) It will be depreciated over time on the income statement and subtracted as a capital expenditure on the statement of cash flows.
B) It will be depreciated over time on the income statement and subtracted as Inventory on the statement of cash flows.
C) It will be depreciated over time on the income statement and therefore not be recorded separately on the statement of cash flows.
D) It will be subtracted from Gross Profit on the income statement and therefore, not be recorded separately on the statement of cash flows.
Answer: A
Q2) How can we cross check the statement of cash flows?
Answer: The last item in the statement of cash flows should equal the difference in cash balances between two adjacent balance sheets.
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4
Chapter 3: Time Value of Money: an Introduction
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Q1) You are scheduled to receive $10,000 in one year. What will be the effect of an increase in the interest rate on the future value of this cash flow?
A) It will cause the future value to fall.
B) It will cause the future value to rise.
C) It will have no effect on the future value.
D) The effect cannot be determined with the information provided.
Answer: C
Q2) A backhoe can dig 180 feet of trench per hour and costs $720 per hour to hire and operate. A ditch digger can dig 6 feet of trench per hour. Based on this information, what is the most a ditch digger can charge for per hour when digging ditches?
A) $24.0 per hour
B) $29.0 per hour
C) $4.0 per hour
D) $48.0 per hour
Answer: A
Q3) How does arbitrage help the Law of One Price?
Answer: Any arbitrage opportunity will exploit any mispricing to restore the Law of One Price.
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Chapter 4: Time Value of Money: Valuing Cash Flow
Streams
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Q1) Can we apply the growing perpetuity equation for negative growth as well?
Q2) How long will it take $50,000 placed in a savings account at 10% interest to grow into $75,000?
A) 4.25 years
B) 3.25 years
C) 5.25 years
D) 6.25 years
Q3) A homeowner in a sunny climate has the opportunity to install a solar water heater in his home for a cost of $2900. After installation the solar water heater will produce a small amount of hot water every day, forever, and will require no maintenance. How much must the homeowner save on water heating costs every year if this is to be a sound investment? (The interest rate is 5% per year.)
A) $145
B) $160
C) $175
D) $190
Q4) How do the growth perpetuity results differ with negative and positive growths of similar magnitude assuming everything else remains unchanged?
Page 6
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Chapter 5: Interest Rates
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Q1) When the costs of an investment come before that investment's benefits, what will be the effect of a rise in interest rates on the attractiveness of that investment to potential investors?
A) It will make it more attractive, since it will increase the investment's net present value (NPV).
B) It will make it more attractive, since it will decrease the investment's net present value (NPV).
C) It will make it less attractive, since it will increase the investment's net present value (NPV).
D) It will make it less attractive, since it will decrease the investment's net present value (NPV).
Q2) A $50,000 new car loan is taken out with the terms 12% APR for 48 months. How much are monthly payments on this loan?
A) $1448.36
B) $1580.03
C) $1316.69
D) $1711.70
Q3) How are interest and return of principal handled in an amortizing loan payment?
Q4) Everything else remaining same, under what situation will APR and EAR be equal?
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Chapter 6: Bonds
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Q1) Consider a zero-coupon bond with a $1000 face value and 15 years left until maturity. If the bond is currently trading for $431, then the yield to maturity on this bond is closest to ________.
A) 2.89%
B) 56.90%
C) 43.10%
D) 5.77%
Q2) What is the yield to maturity of a(n) eight-year, $5000 bond with a 4.4% coupon rate and semiannual coupons if this bond is currently trading for a price of $4723.70?
A) 6.31%
B) 5.26%
C) 7.36%
D) 2.63%
Q3) What is the dirty price of a bond?
A) the bond's price based only on the bond's yield
B) the bond's actual cash price
C) the bond's price based only on coupon payments
D) the bond's price less an adjustment for changes in interest rates
Q4) How are the cash flows of a coupon bond different from an amortizing loan?
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Chapter 7: Stock Valuation
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Q1) What role do dividends play in stock investing?
Q2) NoGrowth Industries presently pays an annual dividend of $1.20 per share and it is expected that these dividend payments will continue indefinitely. If NoGrowth's equity cost of capital is 10%, then the value of a share of NoGrowth's stock is closest to
A) $9.60
B) $14.40
C) $13.20
D) $12.00
Q3) Owen Inc. has a current stock price of $15.00 and is expected to pay a $0.80 dividend in one year. If Owen's equity cost of capital is 12%, what price would its stock be expected to sell for immediately after it pays the dividend?
A) $11.20
B) $12.80
C) $16.80
D) $16.00
Q4) Can the dividend-discount model handle negative growth rates?
Q5) What is the relationship between the growth rate and the cost of equity implied in the dividend-discount model?
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Chapter 8: Investment Decision Rules
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Q1) You can evaluate alternative projects with different lives by calculating and comparing their equivalent annual annuity.
A)True
B)False
Q2) Which of the following statements is FALSE?
A) The payback investment rule is based on the notion that an opportunity that pays back its initial investments quickly is a good idea.
B) An internal rate of return (IRR) will always exist for an investment opportunity.
C) A net present value (NPV) will always exist for an investment opportunity.
D) In general, there can be as many internal rates of return (IRRs) as the number of times the project's cash flows change sign over time.
Q3) When an alternative decision rule disagrees with the net present value (NPV), the NPV should be followed.
A)True
B)False
Q4) Should personal preferences for cash today versus cash tomorrow play a role in the net present value (NPV) decision-making process?
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Chapter 9: Fundamentals of Capital Budgeting
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Q1) If available, should MACRS be preferred to straight-line depreciation?
Q2) Jim owns a farm that he wants to sell. He learns that a highway will be built near the farm in the future, giving access to the farmland from a nearby city and thus making the land attractive to housing developers. Expecting the net present value (NPV) of the sale to be greater after the highway is built, he decides not to sell at this time. What real option is Jim taking?
A) option to delay
B) option to expand
C) option to abandon
D) option to switch
Q3) The cash flow effect from a change in Net Working Capital is always equal in size and opposite in sign to the changes in Net Working Capital.
A)True
B)False
Q4) A real option is the obligation to take a particular business action.
A)True
B)False
Q5) What is the most important function of sensitivity analysis?
Q6) What is the major difference between scenario analysis and sensitivity analysis?
Page 11
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Chapter 10: Stock Valuation: a Second Look
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Q1) Praetorian Industries will pay a dividend of $2.50 per share this year and has an equity cost of capital of 8%. Praetorian's stock is currently trading at $84 per share. By comparing Praetorian with similar firms, an investor expects that its dividends will grow by up to 5% per year. What is the best next step that the investor should take regarding Praetorian's stock?
A) Sell any Praetorian stock that she owns.
B) Short Praetorian's stock.
C) Revise Praetorian's equity cost of capital.
D) Revise her estimate of Praetorian's dividend growth.
Q2) What additional adjustments are required to find the share price, in case we are using the discounted cash flow model?
Q3) In the method of comparables, the known values of a firm's cash flows are used to estimate the unknown cash flows of a similar firm.
A)True
B)False
Q4) Which is the best valuation technique when using comparables?
Q5) What are the implications of the efficient markets hypothesis for corporate managers regarding accounting earnings?
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Chapter 11: Risk and Return in Capital Markets
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Q1) Stocks with high returns are expected to have ________.
A) high variability
B) low variability
C) no relation to variability
D) inverse relationship with variability
Q2) Rational investors ________ fluctuations in the value of their investments. A) are averse to B) prefer C) are indifferent to D) are in favor of
Q3) The S&P 500 index delivered a return of 20%, -10%, 20%, and 5% over four successive years. What is the arithmetic average annual return for four years?
A) 10.50%
B) 13.13%
C) 8.75%
D) 9.63%
Q4) What care, if any, should be taken when selecting stocks for an investment portfolio?
Q5) Which type of investment has historically had the lowest volatility?
Q6) Is volatility a reasonable measure of risk when evaluating large portfolios?
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Chapter 12: Systematic Risk and the Equity Risk Premium
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Q1) Suppose you invest $22,500 by purchasing 200 shares of Abbott Labs (ABT) at $55 per share, 200 shares of Lowes (LOW) at $35 per share, and 100 shares of Ball Corporation (BLL) at $45 per share. The weight of Lowes in your portfolio is ________.
A) 40.44%
B) 21.78%
C) 49.78%
D) 31.11%
Q2) Which of the following statements is FALSE?
A) While the sign of a correlation is easy to interpret, its magnitude is not.
B) Independent risks are uncorrelated.
C) When the covariance equals 0, the returns are uncorrelated.
D) To find the risk of a portfolio, we need to know more than the risk and return of the component stocks; we need to know the degree to which the stocks' returns move together.
Q3) What role does the correlation of two assets play in computation of the expected return of the two asset portfolio?
Q4) Correlation is the degree to which the returns of two stocks share common risks.
A)True B)False
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Chapter 13: The Cost of Capital
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Q1) Which of the following statements is FALSE?
A) Issuance costs increase the WACC.
B) External equity is less expensive than retained earnings.
C) A project that can be financed with internal funds will be less costly than the same project if it were financed with external funds.
D) Issuance costs should be treated as cash outflows in NPV analysis.
Q2) An all-equity firm had a dividend expense of $30,000 last year. The market value of the firm is $900,000 and the dividend is expected to increase at 6% each year. What is the cost of equity for this firm?
A) 9.53%
B) 10.01%
C) 10.96%
D) 11.44%
Q3) A firm's sources of financing, which usually consists of debt and equity, represent its ________.
A) total assets
B) capital
C) total liabilities
D) current liabilities
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Chapter 14: Raising Equity Capital
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Q1) How does the size of an issue affect the fees charged by underwriters?
A) Although large issues generally have a smaller spread, the total fees for large number of shares released is smaller than that for smaller issues.
B) Large issues generally have a similar spread to small issues and thus attract much greater fees.
C) Large issues have a reduced spread, which means that the total fees are generally the same as for smaller issues.
D) Large issues have substantially larger direct costs and, thus, must charge a larger spread in order to be profitable for the underwriter.
Q2) The cost of issuing an IPO in the U.S. is higher than most other security issuance fees. A typical spread is ________.
A) 5%
B) 6%
C) 7%
D) 8%
Q3) What are some of the highlights of Google's IPO process?
Q4) How do the transaction costs of IPO puzzle financial economists?
Q5) What are some of the disadvantages of going public?
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Chapter 15: Debt Financing
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Q1) What is an original issue discount bond?
Q2) Which of the following statements is FALSE?
A) By including more covenants, issuers increase their costs of borrowing.
B) Once bonds are issued, equity holders have an incentive to increase dividends at the expense of debt holders.
C) Covenants may restrict the level of further indebtedness and specify that the issuer must maintain a minimum amount of working capital.
D) If the covenants are designed to reduce agency costs by restricting management's ability to take negative-NPV actions that exploit debt holders, then the reduction in the firm's borrowing cost can more than outweigh the cost of the loss of flexibility associated with covenants.
Q3) Which of the following will have the greatest need of strong bond covenants if it is to receive a high bond rating?
A) a debenture
B) a mortgage bond
C) an asset-backed bond
D) a foreign bond
Q4) What is yield to maturity?
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Chapter 16: Capital Structure
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Q1) Managers should not change the capital structure unless it departs significantly from the optimal level because such a change would ________.
A) reduce dividends
B) incur transactions costs
C) increase fixed costs
D) change incentives of stakeholders
Q2) With perfect capital markets, what is the market value of Luther's equity after the share repurchase?
A) $15 billion
B) $10 billion
C) $25 billion
D) $20 billion
Q3) A firm requires an investment of $60,000 and borrows $30,000 at 9%. If the return on equity is 22% and the tax rate is 35%, what is the firm's WACC?
A) 11.1%
B) 13.9%
C) 16.7%
D) 27.9%
Q4) What are some implications of market imperfections?
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Chapter 17: Payout Policy
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Q1) Dividend payments that are the result of liquidation of assets are known as ________ and are taxed as capital gains.
A) return of capital
B) rolling dividends
C) alternate payments
D) private earnings
Q2) The JRN Corporation will pay a constant dividend of $3 per share per year in perpetuity. Assume that all investors pay a 25% tax on dividends and that there is no capital gains tax. The cost of capital for investing in JRN stock is 14%. The price of a share of JRN's stock is closest to ________.
A) $16.07
B) $12.86
C) $19.29
D) $32.14
Q3) The Record Date falls before the Ex-Dividend Date.
A)True
B)False
Q4) What is the bird-in-the-hand fallacy in dividend theory under perfect capital markets?
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Chapter 18: Financial Modeling and Pro Forma Analysis
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Q1) The estimate of a firm's value at the end of the forecast horizon using a valuation multiple is also called its ________.
A) fixed value
B) payback value
C) terminal value
D) none of the above
Q2) What are a firm's options when it generates more cash than planned?
Q3) The amount of net working capital for Ideko in 2010 is closest to ________.
A) $26,200
B) $35,195
C) $30,510
D) $29,420
Q4) One of the shortcomings of the percent of sales method is that it does not account for the fact that capacity changes are lumpy and not incremental.
A)True
B)False
Q5) Why is EBITDA multiple used for valuation rather than sales or earnings?
Q6) How do we compute net new financing?
Q7) How do we know if expansion is a good idea for the firm?
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Chapter 19: Working Capital Management
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Q1) The level of cash a firm holds is irrelevant; it can never be short of cash since a firm is able to raise new money instantly at a fair rate, while it can never have surplus cash since the firm can invest excess cash at a fair rate to earn a net present value (NPV) of zero.
A)True
B)False
Q2) Collection float is the amount of time it takes for a firm to be able to use funds after a customer has paid for its goods.
A)True
B)False
Q3) Which of the following money market investments is a short-term, unsecured debt obligation issued by a large corporation? The minimum denomination is $25,000, but most have a face value of $100,000 or more.
A) banker's acceptance
B) commercial paper
C) repurchase agreement
D) certificates of deposit
E) Treasury bills
Q4) What is a firm's cash cycle?
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Chapter 20: Short-Term Financial Planning
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Q1) Luther Industries is offered a $1 million dollar loan for four months at an APR of 9%. If this loan has an origination fee of 1%, then the effective annual rate (EAR) for this loan is closest to ________.
A) 12.0%
B) 12.6%
C) 4.1%
D) 13.8%
Q2) What is the term used for a short-term, unsecured debt sold by a large company to an intermediary, who then resells the debt to investors in return for a fee for his or her services?
A) commercial paper
B) direct paper
C) dealer paper
D) unsecured paper
Q3) The permanent working capital needs for Hasbeen Toys is closest to ________.
A) $1,100 million
B) $2,435 million
C) $1,275 million
D) $770 million
Q4) What are compensating balance and what effect does it have on the loan?
Page 22
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Chapter 21: Option Applications and Corporate Finance
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Q1) Consider the following equation: C = P + S - PV(K) - PV(Div)
In this equation, what does the term C represent?
A) the value of the call option
B) the stock's current price
C) the payoff of a zero-coupon bond
D) the strike price of the option
Q2) How many of the January 2009 call options are in-the-money?
A) 1
B) 2
C) 3
D) 4
Q3) The open interest for a January 2011 call option that is closest to being at-the-money is ________.
A) 1436
B) 2245
C) 872
D) 523
Q4) When is an option out-the-money?
Q5) What is the short position of an options contract?
Q6) What is a put option?
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Chapter 22: Mergers and Acquisitions
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Q1) When a hostile takeover appears to be inevitable, a target company will sometimes look for another, friendlier company to acquire it called a ________.
A) poison pill
B) classified board
C) golden parachute
D) white knight
Q2) You work for a levered buyout firm and are evaluating a potential buyout of Boogle Inc. Boogle's stock price is $18, and it has 3 million shares outstanding. You believe that if you buy the company and replace its dismal management team, its value will increase by 50%. You are planning on doing a levered buyout of Boogle and will offer $25 per share for control of the company. Assuming you get 50% control, what will your gain from the transaction be?
Q3) On average, when a bid is announced, the stock price of the target drops.
A)True
B)False
Q4) Assume that Martin pays no premium to acquire Luther. Calculate Martin's price-earnings (P/E) ratio both pre and post merger.
Q5) What is a white knight?
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Chapter 23: International Corporate Finance
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Q1) A ________ exchange rate means that the rate changes constantly depending on the quantity supplied and demanded for the currency.
A) fixed
B) floating
C) banded
D) none of the above
Q2) Luther Industries, a U.S. firm, is considering an investment in Japan. The dollar cost of equity for Luther is 12%. The risk-free interest rates on dollars and yen are r<sub>$</sub> = 5.5% and r<sub>¥</sub> = 1.5%, respectively. Luther Industries is willing to assume that capital markets are internationally integrated. Luther Industries needs to know the comparable cost of equity in Japanese yen for a project with free cash flows that are uncorrelated with spot exchange rates. The yen cost of equity for Luther Industries is closest to ________.
A) 14.0%
B) 12.3%
C) 7.8%
D) 18.5%
Q3) What are the timings of the foreign exchange market?
Q4) What is floating rate?
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Chapter 24: Leasing
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Q1) Which of the following statements is FALSE?
A) Lease payments are a fixed obligation of the firm.
B) The risk of the lease payments is no greater than the risk of secured debt, so it is reasonable to discount the lease payments at the firm's secured borrowing rate.
C) If a firm purchases a piece of equipment, the expense is a capital expenditure. Therefore, the purchase price can be depreciated over time, generating a depreciation tax shield.
D) If the equipment is leased and the lease is a non-tax lease, there is no capital expenditure, but the lease payments are an operating expense.
Q2) Which of the following discount rates should be used for the lease versus borrow decision?
A) the risk-free rate of interest
B) the company's cost of borrowing
C) the company's after-tax cost of borrowing
D) the company's weighted average cost of capital
Q3) If St. Martin purchases the CT scanner, what is the amount of the lease-equivalent loan?
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Chapter 25: Insurance and Risk Management
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Q1) Insurance that compensates for the loss or unavoidable absence of crucial employees in the firm is called ________.
A) key personnel insurance
B) business liability insurance
C) property insurance
D) business interruption insurance
Q2) A manufacturer of breakfast cereal is concerned about corn prices. The firm anticipates needing 1 million bushels of corn in one month. The current price of corn is $6.50 per bushel and the futures price for delivery in one month is $7.00 per bushel. The cost to store the corn for 1 month is $100,000. What should the firm do?
A) Hedge with futures for a total cost of $7,000,000.
B) Hedge with futures for a total cost of $6,900,000.
C) Buy the corn now and store for 1 month, for a total cost of $6,500,000.
D) Buy the corn now and store for 1 month, for a total cost of $6,600,000.
Q3) Assuming that your firm will purchase insurance, what is the minimum-size deductible that would leave your firm with an incentive to implement the new safety policies?
Q4) What is the actuarially fair cost of full insurance?
Q5) What are some of the disadvantages of long-term supply contracts?
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Chapter 26: Corporate Governance
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Q1) Which of the following statements is FALSE?
A) Researchers have hypothesized that boards with a majority of outside directors are better monitors of managerial effort and actions.
B) Studies have found that firms with independent boards make fewer value-creating acquisitions but are more likely to act in shareholders' interests if targeted in an acquisition.
C) One early study showed that a board was more likely to fire the firm's CEO for poor performance if the board had a majority of outside directors.
D) Although the firm's stock price increases on the announcement of its addition of an independent board member, the increased firm value appears to come from the potential for the board to make better decisions on acquisitions and CEO turnover rather than from improvements in the firm's operating performance.
Q2) Directors who are employees, former employees, or family members of employees are called ________.
A) managing directors
B) independent directors
C) inside directors
D) gray directors
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